First-half earnings tipped to fall

Fund managers are confident earnings expectations will be met this reporting season given expectations are relatively low. They have shifted their focus to the outlook commentaries from companies’ managements, which are widely tipped to be the main driver of stock performance over the next few weeks.

“We’ve seen a fair few profit warnings already across the retail sector. At the end of last year we saw profit warnings from Billabong, JB Hi-Fi and David Jones – it’s really put a lot of pressure on the whole discretionary segment. There are weak expectations already factored in there," said Mr Fenton.

“We’re not expecting to see any weakness beyond some of those obvious areas that have really already come out and warned."

But Mr Fenton said a number of companies would still be feeling the pain of the strong Australian dollar, which, much like Australian equities, has been on an upward trajectory so far this year.

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“The strength of the $A continues to weigh on offshore earnings. Anything related to domestic manufacturing or import competing is going to be under pressure."

Earnings per share growth for all listed companies is expected to rise by 3.3 per cent for the 2012 fiscal year, according to Macquarie Equities.

But the broker is also warning that growth forecasts are strongly skewed to the second half, with first-half earnings already tipped to fall 2.9 per cent.

Platypus Asset Management portfolio manager Prasad Patkar agrees. “Most businesses, except perhaps mining services companies, have experienced a tough operating environment in the December 2011 half. The sluggish Australian economy made life hard for domestic cyclicals, retailers and the banks, whilst the strong $A has hurt offshore earners, as did the volatile global macro environment."

Mr Patkar noted earnings expectations had been pared back significantly compared with the middle of last year and said they were now “fairly realistic".

“Considering the relatively few profit warnings leading into the reporting season, it is safe to say that the earnings expectations will be met."

He’ll be watching stocks that have suffered difficult business conditions since the onset of the global financial crisis, including transport, building materials and some diversified financial stocks to see if they are starting to recover.

“Most management teams have weaned the investors and brokers off the ‘specific guidance habit’ of late purely because of the highly uncertain environment that has prevailed since the 2008 crisis. Plus given how tough things have been in the last half, my sense is that investors are expecting subdued outlook comments from most companies this time around.

“It is interesting to see that of the dozen or so companies that have issued subdued trading updates or profit warnings in the last week or so, most have actually traded well. So the market appears to have already priced in a lot of the bad news, so a miss won’t be fatal for a stock if the market gets comfort that earnings have troughed in the last half and you’d expect to see such stocks perform well," said Mr Patkar.

In terms of small industrial stocks, Pengana Emerging Companies Fund portfolio manager Steve Black said analysts were expecting somewhere near 10 per cent earnings growth for the 2012 financial year, which he views as “far too bullish" and expects the actual outcome to be closer to zero, “unless we see a dramatic turnaround in confidence and business conditions improve".

“There is no shortage of quality small industrial companies with management teams that have proven track records of growing earnings through all economic conditions. It is our opinion that the true worth of these companies has not been fully recognised as investors have shunned the small industrial sector for being either too slow or too illiquid."

Fund managers agree that while conditions remain tough and weak results are likely during reporting season, volatility is not tipped to be a big issue. “Weak results should not be a surprise to the market given the challenging macro backdrop in 2011 and current market valuations," said AMP Capital senior investment strategist and portfolio manager Nader Naeimi.

“Consensus expectation for the 2012 financial year earnings per share growth currently stands at just under 6 per cent, having been revised down significantly from more than 13 per cent a year ago. I expect to see further trimming of estimates as the reporting season unfolds and see expectations to settle down in the 1 to 3 per cent range." Mr Naeimi believes the materials sector has the highest possibility of upside surprise as the reporting season progresses.

He said concerns over a hard landing in China and falling commodity prices had led to a significant downward revision in the materials sector earnings expectations.

“On latest measures, the sector’s forecast fiscal 2012 EPS growth estimate is around 22 per cent, below levels from a year ago, the largest fall of all sectors.

“Despite the angst, China is showing increasing signs of transitioning to a more sustainable growth path without a hard landing. China’s record import of refined copper in December 2011 is a reminder of China’s ongoing demand for commodities."